Feeling Hot Hot Hot And What Can Be Done To Cool Things Off

What Is Not Hot

• The weather. Most of the country is experiencing below normal Spring temperatures.
• The Stock and Bond markets. Stocks ending last week on a down note and bond yields over the past few weeks spiking.
• Bitcoin going nowhere the past few months and far away from new highs.
• The Lakers missed the playoffs, only 3 previous times did the 8 straight finals star Labron James miss the post season.

An Abundance Of Issues Are Hot

• Oil prices (shortages of oil in parts of the world, including parts of Europe). Record prices throughout the U.S. with California recently reporting $6 per gallon
• Wheat, corn, soybean oil, and a host of other agricultural products hitting new price highs
• Fruits and vegetables. There may be shortages this summer.
• Automobile prices—especially used cars—are hitting new high prices.
• Travel, especially airline fares (up 10% in March) and rental car prices are way up.
• Housing prices. This includes new, resale and multi-family rentals. Even though mortgage rates are rising fast, higher borrowing costs have so far had a negligible effect on slowing home sales. (Because much of it remains as cash purchases).
• Geopolitical turmoil. Ongoing threatening vitriol makes peace in the world uncertain. Tempers are staying hot and cooperation between countries is breaking down.
• Crime is way up. Prosecutions are way down and the divisiveness between people is way too hot.

The list could continue, but I suspect that all of our readers are witnessing the effects of the aforementioned list of HOT items. And they are just getting Hotter!!!

There are a host of reasons that these are occurring including:

• Coming out of COVID and broken supply chains.
• Too many dollars printed and handed out during the Pandemic.
• The war in Ukraine and shortages in energy and agricultural shipments from that part of the world.
• World turmoil.
• The ongoing COVID problems (China shutting down).
• Pent up demand after the Pandemic.

This morning I visited one of my favorite local places for breakfast. I had not been there since January. I was shocked when I ordered my favorite omelet and found out the price went up 35% from the last time I visited.

I am noticing that just about everything is going up, and everyone is talking about the dirty word….Inflation.

“Inflation is taxation without representation.”
― James Thomas Kesterson Jr

“Inflation is when you pay fifteen dollars for the ten-dollar haircut
you used to get for five dollars when you had hair.”
― Sam Ewing

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It also appears from what a few of the Fed Governors recently said, that the Federal Reserve now believes they are behind the curve and that much more aggressive action needs to be taken immediately.

This hawkish view (see our Market Outlook from last week) has had a swift and detrimental effect on the 10-year Treasury Yield and added 1% to the yield in just a one-month period. That is a 60% rise in rates in 30 days.

This rapid rise in rates has had the most detrimental effect on folks living on fixed incomes. Negative returns in stocks and bonds hurts older, retired Americans depending on this income.

Negative returns are also starting to hurt demand from most Americans who have also been supplanting their incomes with investment returns. They are currently weighed down by rising prices and NOT rising incomes.

This has hit the market with uncertainty and kept a lid on any sustainable positive upward movement. As our own Mish has stated in numerous TV appearances lately, “we are most likely range-bound for the foreseeable future.”

All Americans are aware of the HOT economy and very high inflation. You cannot turn on the TV and listen to a news story without it focusing on rising prices for everything.

This past week saw the PPI (Producer Price Index) come in at 11+% for the year-over-year number. This followed a historical 8.5% CPI (Consumer Price Index) in March.

You will notice that the fastest rise for the PPI (March 2022) comes from Goods and NOT services (chart below). This indicates that the raw materials are rising at a faster pace than most services which typically lead the PPI’s small monthly increases in the past.

The Government may be telling you that your taxes are not going to go up, but when inflation is this high, the cost of everything is a new tax.

Personally, I have watched news stories recently where average Americans are saying that they are trying to determine if gasoline is more important (to get to work) or eating.

I have also watched recent stories about the large and growing number of middle-class Americans having to go to local food banks to help feed their families.

What Will Cool Down the Economy (Provide Relief From High Inflation)?

There are a few ways out of here.

1. The Fed is very aggressive in raising rates and it slows the economy down quickly. The act of multiple Fed rate hikes (at 0.50% or more each time) should begin to subdue the hot economy and rising prices we are currently experiencing. This is what the Fed hopes. Unfortunately, the Fed does not have a particularly good record of creating a smooth and soft landing. The problem is a large number of Economists believe that rates must rise equal to or greater than the rate of inflation. If this were to occur, this would be disastrous for our economy. We probably need to rule that scenario out altogether.
2. The Fed slows things down too much and we enter a recession. This is a much more likely scenario. Some economists believe that the recent inverted yield curve is already forecasting such a scenario.
3. Prices rise so much that there is demand destruction (we are beginning to see this already). People adjust their spending habits and consumer purchases slow. This would hit the economy hard. We could avoid a recession if this occurred perfectly, but again these kinds of slowdowns typically result in a cycle of negative GDP and a recession.
4. We get embroiled in a war. While all eyes are on Russia now, we may need to begin looking at Taiwan. Recent friction there may be preempting a future conflict. War has cured many of the previously mentioned economic issues, but this is not a desirable solution. More importantly, it is doubtful that the American people have much of an appetite for this. It may get pushed off, but we have no qualms that many situations around the world may promulgate this scenario sooner rather than later.

Whatever the solution, the fastest way to dissatisfaction among citizens in the United States is punishing inflation. If this persists, and we believe it will, you will see many changes in the people who are running our country in Washington. There are many things Americans will tolerate, but rising gasoline and food costs are usually not one of them.

Here are a few more insights from our Big View

Risk-On / Bullish

• Biotech (IBB) continues to consolidate in a recovery phase

Risk-Off/Bearish

• Three of the four key US equity indexes closed in bearish phases, with the Dow Industrials hanging on to a distribution phase
• Utilities (XLU) continue its strong relative performance verses equities
• Metals, Commodities and Energy were all up on the week improving on their six-month leadership and all are in bullish phases
• Soft commodities closed on a multi-year high
• Consumer Discretionary (XLY) was down -1.5% while Consumer Staples (XLP) was up almost +.6%.
• Notable pattern in the sector rotation : The worst two groups for the week (SMH, XLK) both spec sectors that love low rates, led market down
• Bonds, especially in the longer durations, got hit hard, while short term rates stabilized moving the yield curve to more normal levels
• Value (VTV) segment remains in a bullish phase, while growth stocks (VUG) moved into a bearish phase
• Volume patterns are extremely weak with only 1 accumulation day across all 4 indexes
• Energy sectors continue to be strong as the war in Ukraine continues to rage

Neutral

• Risk Gauges backed off again to weak neutral with the TSI having negative reading across the board in key equity benchmarks
• VIX measures and sentiment indicators remain in a trading range
• Market internals are in a neutral to slightly negative zone, but adv/decline metrics on a short-term basis are sitting at modestly oversold levels

Written By: Keith Schneider